Securing Outside Financing for Biomass Power Projects

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Incentives included in the recently passed stimulus bill combined with pending renewable portfolio standards (RPS) at the federal level, have created a mass of new project developers hoping to bring biomass power projects to market. All of these developers face the same challenge: securing outside financing. To do this, developers must convince investors and lenders that the projects' fundamentals are secure enough to ensure that financial returns are met. Having a good plan and knowing the requirements are key in today's challenging economic environment.

To secure outside financing developers must create a business plan that addresses areas of concern for lenders. These areas are listed below:

>Environmental Permitting

>Capital Cost

>Power Purchase Agreement

>Fuel Contracts

>Site Selection

>Technology Choice

>Management Expertise

Any project can be approached in a variety of ways. A project may start with negotiation of a power purchase agreement (PPA). A business plan is then developed to support the PPA. Alternatively, a project concept might be to convert an existing fossil fuel plant to biomass. The business plan created will be to support this effort. In any case, a developer typically starts with a concept that he believes will deliver a competitive advantage and the rest of the project is built around that advantage. Whatever the plan, there are some basic steps that most developers follow:

>Feasibility Study

>PPA Negotiation

>Fuel Contract Negotiation

>Environmental Permitting

>Preliminary Engineering

>EPC Bid Package Development

>EPC Firm Selection

>Funding Negotiations

Feasibility Study

The goal of a feasibility study is to firm up the basic business plan. Hunt, Guillot, & Associates' feasibility studies have three basic deliverables: a project proforma, a risk analysis report, and a basic site plan. HGA is an engineering and project management firm specializing in biomass-to-power projects. These three documents allow potential investors to quickly review a project concept and confirm or deny interest in the project.

HGA's risk analysis report addresses the key areas that lenders will be interested in (listed earlier). The report documents the plan, the level of risk, the likelihood of the risk occurring and potential mitigation alternatives. Feasibility studies typically cost $40,000 to $70,000 and last a couple of months.



PPA Negotiation

Terms of a power off-take agreement are critical to a project's viability and should be addressed early in the process. Lenders prefer PPA's that allow the plant owner to avoid fuel cost inflation risk and push fuel costs through to the power purchaser. This arrangement is similar to the typical current arrangements at major utilities where electricity costs vary depending on natural gas, coal, or other fossil fuel costs. Fuel cost increases are passed along to rate payers. Lenders will also prefer PPA agreements with lengths that cover the lending period. For example, if the project is to have a 15-year loan, a 15-year PPA will be desired or required.

One path can be to ask the power purchaser to sign a letter of intent (LOI) to confirm their interest in the project. A formal PPA can be signed at a later date once the project is further developed and any purchaser concerns addressed.

Fuel Contract Negotiation

On the fuel side, lenders want confidence that there will be no fuel challenges resulting in power production stoppages (affecting project returns). Unfortunately because of the localized nature of biomass material, there typically are few, if any, bankable fuel suppliers available. They are usually too small to guarantee a certain price or volume for an extended period. The companies would go bust if the company were forced to meet excessively challenging terms on an ongoing basis.

To address this challenge, lenders typically prefer a fuel study documenting a large fuel basket, and fuel contracts to cover the majority of the fuel needs for the lending period. A similar approach to PPAs can also be taken for fuel providers where LOIs can be signed early in the project life followed by firm contracts once the project is closer to funding.

Environmental Permitting

Environmental permitting can be a major challenge these days given requirements in some areas. For this reason, lenders will require permits to be in place prior to funding a project. Permitting timelines can be excessive (up to two years in some regions), so this area needs to be investigated and started early in the process. A variety of firms can assist with this effort. Permitting costs and environmental consulting services will vary depending on the location of the project.

Preliminary Engineering

Any business plan must include three primary items: revenues, operating costs and capital costs. Preliminary engineering lays the groundwork for understanding capital cost requirements. The following items are typically included as part of preliminary engineering: development of a project design basis, creation of process flow diagrams, layout drawings, equipment lists and supporting work required for permit applications.

Preliminary engineering typically costs about $60,000 and lasts about three months. Additional time and money will be necessary for brownfield projects. Furthermore, additional preliminary engineering will further define the project parameters and ensure that the engineering, procurement and construction (EPC) firm delivers a plant matching the owner's expectations. However, developers are typically seeking to minimize expenditures on the front end so preliminary engineering dollars are usually kept to a minimum.

EPC Bid Package Development
The EPC bid package communicates critical project information necessary for EPC firms in pulling together their project bid. The preliminary engineering serves as the groundwork for the technical portion of the EPC bid package. Additional language clarifies responsibilities, performance requirements, bonding requirements, schedule targets and other information required by interested firms. Engineering firms typically assemble very basic EPC bid packages for less than $15,000 and this effort should take no more than a few weeks.

EPC Firm Selection

Selection of an EPC firm is a critical step in the development process. The firm should fit with the project goals and lender requirements. These days many lenders are requiring an EPC contract with full wrap including performance guarantees and bond. This arrangement will be a challenge for many smaller EPCs. This arrangement will also result in the highest EPC bid due to increased risk. A consortium of service providers will likely result in lower overall project costs, but might not be able to meet other lender requirements.

In the end, the EPC firm needs to have experience in biomass power and in managing projects of equivalent size and scope. The firm must be available and able to meet the schedule required. When front end project costs are minimized, as outside financed projects typically are, the resulting EPC bid package is typically rough. This can lead to great diversity in the approaches EPC firms propose and the resulting bid amount. Bids need to be reviewed carefully and approaches discussed extensively to ensure that everyone-developer, lender, EPC firm and engineering counsel-is on the same page. It is common for developers without engineering expertise to hire an owner's engineer to assist with the feasibility study, preliminary engineering, bid package development and EPC firm selection.

"In this environment, experience and the ability to bond a project are key features we look for in an EPC firm," says Peyton Bush of FVC, a private equity firm based in New Orleans.

Funding Negotiation

Financing typically involves negotiations with two classes of lenders: equity and debt. Equity lenders take on more risk and therefore share more in the upside of a project. Lenders lock in for a set rate of return and incur less project risk. In this environment, equity providers are typically seeking returns of around 20 percent. Given the availability of government-backed loans, debt providers are willing to loan at about 8 percent to 10 percent.

Funding negotiations can be lengthy and frustrating in today's environment, but there are lenders willing to support worthwhile projects. A common approach is to engage equity providers early (generally after the feasibility study is completed) to understand their interest, key issues, risk appetite, hurdle rates and preferences for doing business. This approach can help to ensure that there are no surprises late in the game. Debt providers are typically brought in once construction is ready to start.

Most debt providers prefer a project to have 20 percent equity at minimum before considering funding a project. However, some debt lenders are starting to consider a new approach. The recently passed stimulus bill allows developers to take the 30 percent investment tax credit (ITC) in the form of a cash grant. This grant is paid 60 days after plant commissioning. Some lenders are considering allowing this cash payment to serve as the equity in the project. This means an investor could potentially develop a project for only a few hundred thousand dollars in front-end development costs.

"Using the ITC cash grant in lieu of equity investment presents an exciting option for the developer," says Brent Knight at Cobank, a Denver-based project debt provider. "However, a project will have to have excellent fundamentals for us to approve this approach."

In the end, the lenders have what developers need-money. It makes good sense to engage them early and keep them engaged throughout the process. It also makes final negotiations go more smoothly.

Conclusion
Incentives included in the recently passed stimulus bill combined with pending renewable portfolio standards at the federal level, have created a mass of new project developers hoping to bring biomass power projects to market. All of these developers face the same challenge: securing outside financing. To do this, developers must convince investors and lenders that the projects' fundamentals are secure enough to ensure that financial returns are met. Having a good plan and knowing the requirements are key in today's challenging economic environment. Selecting the right service providers and partners can make all the difference.

Trotter Hunt is a relationship manager at Hunt, Guillot & Associates LLC. Reach him at [email protected] or (318) 251-5929.